Mention the word behavioural pscyhology and a few well-known names come to mind. Kahneman, Baumeister, Thaler, and to a certain extent, Taleb are just a few examples. So it was a bit surprising when I came across a book by a relatively unknown author. But given that investing is a passion, and books are my weakness, I had to read this book.
Although I have devoured path breaking books such as Thinking – Fast and Slow, Misbehaving, etc. I had found these books to be quite dense. I had to conjure up all my willpower (no pun intended – Willpower Baumeister) to keep from falling asleep. But I found this book by Daniel Crosby to be a much more accessible read, and because it directly dealt with how behavioural psychology links with the stock market, it was much more relevant as well.
The book is divided into four parts. The first part of the book talks about how non-rational cues affect the way an average retail investor chooses to invest in the stock market. Various affecting factors such as sociology, physiology are discussed. Many of these factors prevent an investor from buying into the right stocks, as well as buying them at the right time. According to the author, all exceptional investing is, at its core, behavioural investing.
As expected with all books that try to explain how humans behave the way they do, this book also relies on the popular trope by comparing us with the way our ancestors on the savannah might have dealt with dangers. And here comes a small but passionate rant. No matter how many books on anthropology, evolution or behavioural psychology I read, I cannot bring to myself the fact that justifying all our present day behaviour by saying that this is what our ancestors on the jungle plains used to do is correct. I am no expert in the subject and I may be very well completely wrong. But my brain refuses to believe that this is so. End rant. And so I have to be patient while reading gems such as…
Our brains have remained relatively stagnant over the last 150,000 years, but the complexity of the world in which they operate has exponentiated (sic). It would be a gross understatement to say that our mental hardware has not caught up to the times. We are simultaneously the most evolved species on the planet and wholly unprepared for the demands of modern life.
But the way that the author explains the various fallacies that the human brain is capable of is quite enlightening, and quite true from my own short experience in the stock market. As a side note, the author quotes many famous experiments that were the pioneered the way for behavioural ecnomics/pschyhology as a discipline. In case you’ve read the books by any of the authors I mentioned earlier, you would already be familiar with these experiments. The Milgram, Stroop test, Stanford prison experiments, are just a few well known and oft-repeated studies in these areas.
In the second part, the author groups all the various biases and fallacies that one normally encounters into four groups. According to him, each of these biases can be classified into one of these categories – Ego, Conservatism, Attention, and Emotion. Quite a convenient classification.
In the next part of the book, the author lays down how one can fight each of these biases in order to make better decisions, especially as far as investment in the stock market is concerned. This is something quite good and useful because as the author mentions at the beginning of this part, that is largely what behavioral finance has given the investing public: a long list of biases with very few solutions. And by including the possible solutions to these biases, the author goes one step further in helping out the average Joe in how he can overcome these behavioural fallacies.
Many of the well-known best practices about investing have been presented from a behavioural perspective. For example, one of the ways in which the ill-effects of ego can be overcome is to diversify. Diversification has become such a broadly accepted good in asset management that it seems many have forgotten the underlying reasons for doing it. Considered from a behavioral lens, diversification is humility made flesh, the embodiment of managing ego risk. Diversification is a concrete nod to the luck and uncertainty inherent in money management and an admission that the future is unknowable.
In my own personal experience, emotion can play a very detrimental role in proper investing. Anger, fear and greed are just some examples under the influence of which thousands of people have lost their savings in the stock market. Hence it becomes imperative to redirect this powerful force in the correct manner. This approach of working with a powerful force and not against a powerful force is instructive to investors seeking to manage emotion en route to making wise investment decisions. It can be tempting to want to stop emotion in its tracks, but, oftentimes, the more adaptive approach is to repurpose it for more favorable outcomes.
The fourth part of the book talks about building a Behavioural Portfolio (whatever that means) as an alternate way to investing. For some reason, the author chooses to discuss the pros and cons of value investing and momentum investing in this part as well. In the end what is prescribed is a combination of both. This was quite surprising and unexpected that the author would simply prescribe such a incompatible investment strategy.
Is this book useful to the beginner investor? Definitely. This may not teach you about which stocks to select or how to read price charts but it will definitely help you understand how to keep your mind clear whenever you’re starting to use whichever investing methodology you follow. And it will help you keep a clear and stable mind as you ride the ups and downs of the stock market, watching the value of your portfolio fluctuate in ever-greater volatile times.
One thing I particularly liked about the book is the way all the references are listed at the end of each chapter. This provides a useful list of further reading. And the best ideas of the chapter presented at the end provide a ready made summary for when you want to revisit the ideas given in the book.
Yes. many of the ideas given in the book are already discussed by the famous scientists/authors mentioned in the opening paragraph. But the book does a decent job to link them to a specific activity – stock market investing and provide a basic framework to keep in mind. The book is maybe a little too fluffed up and the editor could have done with a much short fourth part. But all in all, you can simply skip or skim these parts while keeping the gist of the book well intact.
In closing, I would like to share the importance of keeping a behavioural perspective in the stock market, no matter how intelligent (you think) you are. After all, the stock market is something that even the best of us can get up in.
Isaac Newton, a scientist without equal, lost his fortune in the South Sea Bubble through a fundamental misunderstanding of the nature of markets and human behavior. Smarts, it would seem, are no guarantee of being a rational actor.
Even once we are aware of our biases, we must recognize that knowledge does not equal behavior. -Nassim Taleb